Two recent court decisions, in Minnesota and Colorado, could have a profound influence on state and local pension woes. In both places courts ruled that states had the right to reduce annual cost-of-living adjustments in pensions for public employees in order to save money. Unions had sued, arguing that reform legislation passed last year which cut COLAs violated the terms of employee contracts, but the courts disagreed.The court victory for the states is important because others are eying similar legislation. New Jersey's recently passed reform legislation also eliminates COLAs for retirees, and unions there have also vowed to sue.
Experts project that the savings could be substantial, far more than many average taxpayers realize, because COLAs, which are common in public pensions but rare in the private sector, rapidly raise costs thanks to the magic of annual compound growth. In fact, pension experts Robert Novy-Marx of the University of Rochester and Joshua Rauh of the Kellogg School of Management at Northwestern University estimated in a paper last year that eliminating annual pension COLAs for state and local workers could cut unfunded liabilities of state systems by half, or about $1.5 trillion. Even a 1 percentage point reduction in COLAs would cut liabilities by 10 percent.
Albert Einstein is reputed to have once exclaimed that compounded interest was the "greatest mathematical discovery of all time." Maybe the story's apocryphal, but if eliminating COLAs alone can make that big of a difference on pension debt, it's something that every system which awards this perk should look closely at trimming.